UK’s MPC set to hike in May, but is the market pricing in enough?


Last week the Bank of England’s Monetary Policy Committee (MPC) left rates on hold at 0.5% as expected by the market, but the Minutes that were released showed a central bank very clearly intending to hike at the next meeting in May. A surprise to the market was the fact that the vote to leave rates on hold came in at 7-2, versus market expectations of a unanimous decision.

 

The statement included the following passage;

 

“As in February, the best collective judgement of the MPC remains that, given the prospect of excess demand over the forecast period, an ongoing tightening of monetary policy over the forecast period will be appropriate to return inflation sustainably to it’s target at a more conventional horizon.”

 

 

 

Source: Bloomberg

 

 

With recent data showing rising retail sales and near record low unemployment in Britain, as well as inflation remaining well above the MPC’s target of 2% (headline CPI is at 2.7% currently), the only factors that the MPC has been concerned about is the sustainability of the global growth picture, and he potential negative impacts of Brexit on the UK economy.

 

 

Source: Bloomberg

 

As more and more data is released it is becoming clearer that in general the global economy is continuing to do well.  The IMF in January released an upbeat report on the global outlook, revising the growth forecasts to 3.9% from 3.7%.

 

There has also been some positive development since the Brexit situation, with the EU Council on Friday endorsing a transition period and the opening up of a new strand of negotiations on the future relationship, which gives the UK more time to come up with a solution on the Northern Ireland border issue.

 

Amidst this backdrop, the question becomes; how “limited and gradual” the rise in UK interest rates will be post- the May hike. The market is currently pricing in only three rate hikes over the next two years, which seems very low compared to the pace and overall tightening in previous cycles.  There is a good chance that rates will rise faster than the market expects.  What this means for GBP is up for debate, as more than just interest rate differentials drive currency markets, and our core view is for a depreciation of GBP this year relative to both USD and EUR, but if the market decides to up their forecast for rate hikes, we could see a short-term rally in GBP before the sell off.

 

 

Author: John Glover



 

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